7 Strategy essentials for electronics manufacturing services (EMS) and ODM providers

VentureOutsource.com, in partnership with IDC's electronics manufacturing research initiative, presents exclusively for VentureOutsource.com readers, 7 strategy essentials for success in the electronics manufacturing services (EMS) and original design manufacturing (ODM) marketplace. Changes in the credit markets amid a worldwide recession; strategic business models to drive ROIC and protect margins, definitive value propositions and more are just some of the essential guidelines EMS and ODM companies should clearly look into should executives want to remain competitive in this hyper-competitive marketplace. The information that follows is part of a larger report on the EMS sector written by Michael Palma, senior research analyst at IDC responsible for electronics manufacturing services and consumer device semiconductors. We are entering a period of economic disruption and EMS / ODM companies need to take steps to address this situation. Fallout from the US home financing meltdown and a general credit crunch will disrupt markets, despite the growth seen in the first half of 2008. EMS / ODMs need to identify weaknesses in their portfolios, speed up reorganization plans, and otherwise prepare for weaker demand, especially from consumer-oriented markets in the short-term, without causing undue pain for OEMs. Purchasing activities should be monitored closely along with inventory levels. Projects with long lead-times are particularly risky in terms of growing inventories from weakening demand. Given the falling value of the dollar, among other factors, offshoring production is likely not the answer to this slowdown. While moving production offshore helped the EMS industry weather the fallout from the dotcom crisis and the last recession, most production that can be moved to lower cost locations has already been sent offshore. Also, demand in key end-markets in Asia may be at risk from rising inflation and lower exports due to weak demand from the US and Europe as a result of the financial crisis in the US. As we enter this period of economic disruption, EMS / ODMs need to take steps to address this situation, such as: 1. The current economic disruption reinforces the need for EMS / ODMs to evaluate current product and customer portfolios With a likely economic disruption, this may be an appropriate time for EMS / ODMs to evaluate their product and customer portfolios. Clients and the products EMS / ODMs manufacture for these clients largely determine financial success. OEMs with products enjoying success in the market place are critical. EMS / ODMs need to determine which OEMs are likely to succeed in the coming years and do their best to keep these clients and win business from other likely successful OEMs. They should also look to expand relationships to win production for additional products, if they make sense within the EMS / ODMs business model. For other OEMs that may be facing a more difficult time, EMS / ODMs should be looking at these relationships and determining whether these programs are achieving profitability goals. If not, EMS / ODMs may need to renegotiate terms to bring them in line with goals. What is key is the relationship between the EMS / ODM and the team at the OEM? While terms can be adjusted to reflect the performance of individual products, maintaining the relationship works for both parties. The OEM knows the risks of working with the specific EMS / ODM and does not need to go through the painful process of searching for new partners. EMS / ODMs can reap existing relationships for future opportunities, reducing the cost of sales. Also by investing in relationships, as executives move to new organizations, the EMS / ODM can find a way into new customers. Relationships can also pay off in the long run. If the OEM switches to another EMS / ODM partner and runs into problems, they may switch back to their previous EMS / ODM partner. 2. EMS / ODMs must ensure their strategy, business model, and operations are aligned with each other To achieve ROIC goals and to maximize profitability, EMS / ODMs must ensure their investment agendas; operational footprints, organizational structures, and business models are aligned with their corporate strategies. The most critical element appears to entail identifying what their strategy actually is, which then identifies what part of the market they play in, which will then tend to determine the appropriate vertical integration strategies, global footprint, and business model. These factors influence marketing activities and the types of business relationships they maintain, including which customers to service and which customers to walk away from, even if in the short term it means passing up on business opportunities. As these factors align, it becomes easier to identify needed skills and technologies companies should invest in. Without alignment, investments will be squandered and organizations will continue to flounder, despite revenue growth. 3. EMS / ODMs must evaluate their value proposition if they are to going to be able to achieve their ROIC goals, which will become increasingly important over the next several years Most firms appear to be falling behind on these goals. This does not seem to be an immediate problem for EMS / ODMs; but the time is coming when this issue must be addressed. Investors are already disappointed with the value many EMS / ODMs are delivering but are hoping that quality initiatives, fiscal management, and consolidation will turn the industry around. The critical issue is the value EMS / ODMs can achieve from OEMs, who are constantly pressuring EMS / ODMs for cost reductions. While this has helped keep ASPs low, bolstering demand, it means tight margins for EMS / ODMs. EMS / ODMs find themselves caught between component manufacturers and OEMs, each trying to maximize profits, without much leverage to increase their profitability. As a result, the current business model paradigm for the EMS industry is one of low margins with operational execution the key variable determining profitability within each EMS / ODMs' business model and financial structure. Until this paradigm changes, the industry will continued to be challenged by low margins. 4. To achieve the next level of cost reduction for OEMs, increased investments are needed during project ramps and for ongoing process improvement efforts to boost efficiencies OEMs and their EMS / ODMs need to evaluate if current project ramp procedures are sufficient? Often, waste and inefficiencies in the supply chain and manufacturing processes are the result of project ramp initiatives that do not fully examine OEM, EMS / ODM, and supplier operations and procedures, and the communications and linkages across the three sets of actors, down to the lowest level of execution. Proof of this can be seen in efforts to eliminate waste in ongoing projects, such as quarterly or annual Kaizen-like events several EMS firms conduct. These efforts have identified significant sources of waste and opportunities to improve efficiencies. Much of this waste could probably be identified during project ramps. Greater investments in upfront project planning will demonstrate the value of EMS / ODMs and help OEMs achieve their cost reduction goals while helping EMS / ODMs reduce their costs. The challenge is that EMS / ODMs are reluctant to further invest in work 6-18 months before cash flow is generated from manufacturing and since the OEMs may cancel projects with limited penalties at any point in the product lifecycle. OEMs should be paying for such services, because of the value these services provide, independent of the preparations needed for mass production of a product. Positioning such services as part of a profit center is a crucial step in ensuring their value is recognized. At the same time, process improvement initiatives need to be recognized as value-added opportunities. 5. EMS / ODMs need to be aware of possible issues of concerns from OEMs that may threaten their relationships. In addition to issues around IP protection, inventory management, and manufacturing quality, several other issues are starting to become more important: Conflict over cash management OEMs tend to want to stretch out payments to maximize their own cash management while EMS / ODMs want to reduce payment terms to boost their performance Continued reorganization and consolidation adding costs to OEMS Given that OEMs certify specific manufacturing lines, every time a facility is consolidate or eliminated and the line moved to another location, the OEM incurs various costs, especially around certification and training of both manufacturing and administrative personnel. There are also opportunities for disruptions that lead to increased costs, along with various end-of-life costs for the OEM, associated with shutting down a location. Increased production costs Raw material, transportation, and labor costs have all been rising over the past two years, frustrating OEM efforts to reduce costs to support the ever increasing erosion of retail pricing and improving their own margins. 6. Vertical integration brings profits, costs, and risks in higher mix, lower volume models Vertical integration is a popular option to boost profitability, allowing the EMS / ODM firm to capture a greater percentage of OEM spending. For the OEM, they can guarantee supply and reap several benefits from supply chain efficiency. The challenge is that establishing component manufacturing operations require additional management resources; capital investments, operational expenses, and purchasing and logistics requirements. Along with these costs are increased risks due to fluid end-customer demand. Finally, in many cases to make such operations profitable, their capacity and production output may need to be in excess of demand generated by their OEM customers to compete against outside suppliers. As a result, EMS / ODMs often need to sell excess production to other customers and competing contract manufacturers. At the same time, conflict can arise between the goals of a successful component business with those of the contract manufacturer satisfying OEM customers' requirements. 7. ODMs need to look beyond the notebooks and mobile phones for future growth opportunities Currently, ODMs are highly dependent on end-markets for notebook computers and mobile phones. Growth in these sectors is slowing and a serious disruption in these markets will be catastrophic for ODMs. Servers and storage, while appearing as an attractive opportunity may prove not to be an attractive opportunity for most ODMs. Concerns of intellectual property protection may cause reluctance to outsource higher end products to ODMs. Also, success in this sector often entails a large on-shore or at least near-shore presence since shipping costs for completed systems are much higher than for personal computers plus, support requirements are higher. Additionally, volume levels are also lower, which means ODMs will need to make adjustments to their business models. Product design and technical requirements are also different and require expertise in a wider array of technologies. The latest trend is towards MIDs (Mobile Internet Devices), which as a category, cannibalizes both the notebook and mobile phone market and remains a dubious opportunity, with several OEMs questioning the viability of this opportunity. VentureOutsource.com, IDC, December 2008 Article sponsored by TechScapeReport.com